Isle of Man: New Substance Requirements For Isle Of Man Companies - Effective 1 January 2019

The Isle of Man Treasury has published a draft of the proposed
Income Tax (Substance Requirements) Order 2018. This draft Order
will, once final, and if approved by Tynwald (in December 2018),
have effect in respect of accounting periods commencing on or after
1 January 2019.

This means that from January 2019, companies engaging in
"relevant activities" will have to demonstrate that they
meet specific substance requirements, to avoid sanctions.

This Order is in response to a comprehensive review that was
carried out by the EU Code of Conduct Group on Business Taxation
(COCG) in order to assess over 90 jurisdictions, including the Isle
of Man (IOM) against standards of:

Tax transparency;

Fair taxation;

Compliance with anti-BEPS
(base-erosion profit shifting)

The review process took place in 2017 and although the COCG were
satisfied that the IOM met the standards for tax transparency and
compliance with anti-BEPS measures, the COGC raised concerns that
the IOM, and other Crown Dependencies did not have:

"A legal substance requirement for entities doing business
in or through the jurisdiction."

High Level Principles

The purpose of the proposed legislation is to address the
concerns that companies in the IOM (and other Crown Dependencies)
could be used to attract profits that are not commensurate with
economic activities and substantial economic presence in the
IOM.

The proposed legislation therefore requires relevant sector
companies to demonstrate they have substance in the Island by:

Being directed and managed in the
Island; and

Conducting Core Income Generating
Activities (CIGA) in the Island; and

Having adequate people, premises and
expenditure in the

Each of these requirements is discussed in further detail
below.

The IOM's Response

In late 2017, along with many other jurisdictions facing
potential blacklisting, the IOM committed to address these concerns
by the end of December 2018.

Due to identical concerns being raised in Guernsey and Jersey,
the governments of the IOM, Guernsey and Jersey have been working
closely together to develop proposals to meet their
commitments.

As a result of the work published in Guernsey and Jersey, the
IOM has published its legislation and limited guidance, in draft.
Please note further guidance will be forthcoming in due course.

The legislation is similar across the three jurisdictions.

The remainder of this article focuses specifically on the IOM
draft legislation.

The Income Tax (Substance Requirements) Order 2018

This Order will be made by the Treasury and is an amendment to
the Income Tax Act 1970.

This new legislation sets out to address EU Commission and COCG
concerns by way of a three-stage process:

To identify companies carrying out
"relevant activities"; and

To impose substance requirements on
companies undertaking relevant activities; and

To enforce the substance

Each of these stages and their ramifications are discussed
below.

Stage 1: To identify companies carrying out "relevant
activities"

The Order will apply to IOM tax resident companies engaged in
relevant sectors. The relevant sectors are as follows:

banking

insurance

shipping

fund management (this does not
include companies that are Collective Investment
Vehicles)

financing and leasing

headquartering

operation of a holding
company

holding intellectual property
(IP)

distribution and service
centres

These are the sectors identified as a result of the work, by the
Organisation for Economic Cooperation and Development's (OECD)
Forum on Harmful Tax Practices (FHTP), on preferential regimes.
This list represents the categories of geographically mobile income
i.e. these are the sectors which are at risk of operating and
deriving their income from jurisdictions other than those in which
they are registered.

There is no de minimus in terms of income, the legislation will
apply to all companies carrying on relevant activities where any
level of income is received.

A key determinant is tax residence and the Assessor has
indicated that existing practice will prevail, i.e. the rules set
out in PN 144/07. Therefore where non-IOM incorporated companies
are engaged in relevant sectors they will only be brought within
the scope of the Order if they are IOM tax resident. This is
clearly an important consideration: if resident elsewhere the rules
relevant to that country of residence are likely to be the binding
rules.

The specific substance requirements vary by relevant sector.
Broadly speaking, for a relevant sector company (other than a pure
equity holding company) to have adequate substance it must ensure
that:

It is directed and managed in
the

The Order specifies that the company is directed and managed* in
the Island. Regular board meetings should take place on the Island,
there must be a quorum of directors physically present at the
meeting, strategic decisions must be made at the meetings, the
minutes of the board meetings must be kept on Island and the
directors present at these meetings must have the necessary
knowledge and expertise ensure that the board can discharge
its' duties.

* Note that the test for "directed and managed" is a
separate test to the "management and control" test which
is used to determine the tax residence of a company. The aim of the
directed and managed test is to ensure that there are an adequate
number of Board meetings held and attended in the Island. Not all
Board meetings need to be held on Island, we discuss the meaning of
"adequate" later in this article.

There is an adequate number of
qualified employees in the Island

This stipulation appears to be rather vague as the legislation
specifically states that the employees do not need to be employed
by the company, this condition focuses on there being an adequate
number of skilled workers present on Island, whether or not they
are employed elsewhere does not matter.

In addition, what is meant by 'adequate' in terms of
numbers is very subjective and for the purpose of this proposed
legislation, 'adequate' will take its ordinary meaning, as
discussed below.

It has adequate expenditure,
proportionate to the level of activity carried on in the

Again, another subjective measure. It would, however, be
unrealistic to apply a specific formula across all businesses, as
each business is unique in its own right and it is the
responsibility of the Board of Directors to ensure that such
conditions are met.

It has adequate physical presence in
the Island.

Although not defined, this is likely to include owning or
leasing an office, having 'adequate' number of staff, both
administrative and specialist or qualified staff working in the
office, computers, telephone and internet connection etc.

It conducts core income-generating
activity in the Island

The Order attempts to specify what is meant by 'core
income-generating activity' (CIGA) for each
of the relevant sectors, the list of activities are intended as a
guide, not all companies will carry out all of the activities
specified, but they must carry out some in order to comply.

If an activity is not part of the CIGA, for example, back office
IT functions, the company may outsource all or part of this
activity without there being an effect upon the company's
ability to comply with the substance requirement. Likewise, the
company may seek expert professional advice or engage specialists
in other jurisdictions without effecting its compliance with the
substance requirements.

In essence, CIGA ensures that the main operations of the
business, i.e. the operations which produce the bulk of the income
are carried out in the Island.

Outsourcing

Further to that mentioned above, a company may outsource, i.e.
contract or delegate to a third party or group company, some or all
of its activities. Outsourcing is only a potential issue if it
relates to CIGA. If some, or all, of the CIGA are outsourced, the
company must be able to demonstrate that there is adequate
supervision of the outsourced activity and that the outsourcing is
to an IOM businesses (which themselves have adequate resources to
perform such duties). Precise details of the outsourced activity,
including, for example, timesheets must be kept by the contracting
company.

The key here is the value that the activities outsourced
generate, if CIGA. In some instances, for example,
outsourcing coding activities, very little might be generated in
terms of value, but it could be design, marketing and other
activities carried out locally that are integral to value creation.
Companies will need to look closely at where the value comes from,
ie who generates it to assess whether outsourced activities are an
issue.

"Adequate"

The term 'adequate' is intended to take its dictionary
definition:

"Enough or satisfactory for a particular purpose."

The Assessor has advised that:

"What is adequate for each company will be dependent upon
the particular facts of the company and its business
activity."

This will vary for each relevant sector entity and the onus is
on the relevant company to ensure that it maintains and retains
sufficient records which demonstrate that it has adequate resources
in the Island.

Stage 3: To enforce the substance requirements

The Order provides the Assessor with the power to request any
information required to satisfy her that a relevant sector company
meets the substance requirements. Where the Assessor is not
satisfied that the substance requirements have been met for a
particular period, sanctions will apply.

Verification of Substance Requirements

The draft legislation provides the Assessor with the power to
request further information from a relevant sector company in order
to satisfy herself that the substance requirements have been
met.

Failure to comply with the request can result in a fine not
exceeding £10,000. Where the Assessor is not satisfied that
the substance requirements have been met, sanctions will apply.

High-risk IP Companies

Generally speaking, the designation 'high-risk IP
companies' refers to companies holding IP where (a) the IP has
been transferred into the Island post-development and/ or the main
utilisation of the IP is off-Island or (b) where IP is held on
Island but the CIGA are carried out off-island.

As the risks of profit shifting are considered to be greater,
the legislation has taken a rather hard approach to high risk IP
companies, it takes the position of 'guilty unless proven
otherwise'.

High-risk IP companies will have to prove for each period that
the adequate substance requirements in respect of conducting core
income-generating activity have been met in the Island. For each
high risk IP company, the tax authorities of the IOM will exchange
all of the information provided by the company with the relevant EU
Member State authority where the immediate and/or ultimate parent
and beneficial owner is/are resident. This will be in accordance
with the existing international tax exchange agreements.

"To rebut the presumption and not incur further sanctions,
the high risk IP company will have to provide evidence explaining
how the DEMPE (development, enhancement, maintenance, protection
and exploitation) functions have been under its control and this
had involved people who are highly skilled and perform their core
activities in the Island".

The high evidential threshold includes detailed business plans,
concrete evidence that decision making occurs in the Island and
detailed information regarding their IOM employees.

Sanctions

In line with the tougher approach taken towards IP companies
detailed above, sanctions are somewhat harsher for such
companies.

Whether or not the substance requirements have been met, in
accordance with international arrangement, the Assessor will
disclose to a relevant EU tax official any relevant information
concerning a high-risk IP company.

If a high-risk IP company is unable to rebut the presumption
that it has failed to meet the substance requirements, the
sanctions are as follows, (stated by the number of consecutive
years of non-compliance):

1st year, a civil penalty of
£50,000

2nd year, a civil penalty of
£100,000 and may be struck off the company register

3rd year, strike the company off the
company register

If the high-risk IP company is unable to provide the Assessor
with any additional information requested, the company will be
fined a maximum £10,000.

For all other companies engaged in relevant sectors (other than
high risk IP), the sanctions are as follows, (stated by the number
of consecutive years of non-compliance):

1st year, a civil penalty of
£10,000

2nd year, a civil penalty of
£50,000

3rd year, a civil penalty of
£100,000 and may be struck off the company register

4th year, strike the company off the
company register

For any year of non-compliance of a company operating in a
relevant sector, the Assessor will disclose to an EU tax official
any relevant information which relates to the company, this could
represent a serious reputational risk to the company.

Anti-avoidance

If the Assessor finds that in any accounting period a company
has avoided or attempted to avoid the application of this Order,
the Assessor may:

Disclose information to a foreign tax
official

Issue to the company a civil penalty
of £10,000

A person (note that "a person" is not defined within
this legislation) who has fraudulently avoided or seeks to avoid
the application is liable to:

On conviction: custody for a maximum
of 7 years, a fine or both

On summary conviction: custody for a
maximum of 6 months, a fine not exceeding £10,000, or
both

Disclosure of information to a
foreign tax official

Any appeals will be heard by the Commissioners who may confirm,
vary or reverse the Assessor's decision.

Conclusion

Companies operating in relevant sector industries are now under
pressure to ensure that they comply with the new legislation which
will commence at the start of 2019.

This will have a significant affect upon many IOM businesses who
have only a short amount of time to demonstrate to the authorities
that they are compliant. The potential penalties of non-compliance
may cause detrimental reputational risk, fines of up to
£100,000 and could even cause a company to eventually be
struck off, after potentially, as little as two years of continuous
non-compliance for high risk IP companies and three years of
non-compliance for other relevant sector companies.

Where does this leave us?

All companies must consider whether they fall within the
relevant sectors, if not then there are no obligations falling upon
them by this Order. However, if they are in a relevant sector then
they will need to assess their position.

Many companies will be easily able to identify whether or not
they fall within a relevant sector and companies managed by CSPs
may need to assess whether they have the necessary substance.

What might change?

We are on the brink of Brexit and, to date, much of the
discussions have taken place with the EU commission and the draft
legislation has been reviewed by them; however, the COCG will only
meet to discuss such matters as blacklisting in February 2019.

It therefore remains to be seen whether the COCG agree that the
proposals go far enough. What is clear, is that this legislation is
here to stay in some shape or form and therefore companies need to
consider their position as soon as possible.

Reporting

The earliest reporting date would be accounting period ended 31
December 2019 and therefore reporting by 1 January 2020.

Corporate tax returns will be amended to include sections which
will gather the information in relation to the substance
requirements for companies operating within relevant sector
industries.

How can we help?

If you think that your business may be affected by the new
legislation, it is important that you begin assessing and taking
appropriate action now. Please contact the Dixcart office in the
Isle of Man to discuss substance requirements in more detail:
advice.iom@dixcart.com.

General Registry and the Ministry of Financial Services have met with local banks to address concerns surrounding banking requirements for charitable organisations, specifically in relation to the opening of bank accounts by non-profit organisations.

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